News

Unstable markets

Some primary markets can become unstable and require intervention to
help them stabilise. In particular, many food producers suffer three
main economic problems:

Falling long term income.

Unstable prices.

Loss of bargaining power to big supermarket chains.

Falling incomes

Farm incomes have fallen in the long term because the supply of food has
increased. Supply has increased for a number of reasons, including:

The greater use of new technology, and better
crop yields.

New entrants into the market, such as Vietnam,
which entered the coffee market in the 1980s, have also helped shift
the market supply curve to the right.

Loss of power to the big supermarket chains

Loss of power to the big supermarket chains,
which means that supermarkets can dictate terms and prices to
farmers. The buying power of supermarkets is referred to as
monopsony power. Farmers are price takers which means they have to accept the price that the
supermarkets dictate, supermarkets are the price makers.

Supply has increased due to
the application of more efficient production methods and, in some cases,
new entrants into the market

However, demand has not increased in the long run, so revenue (P x Q)
falls. In fact, the demand for some food has fallen over time.

Revenue 0PAQ is clearly larger than revenue 0P1BQ1.

Unstable prices

Many commodity markets exhibit short term instability.

Movements
in cocoa prices are
typical of many commodity markets, which tend to exhibit considerable
volatility. These price movements usually reflect changes in
conditions of supply - with changes in weather patterns (such as
el Nino conditions) and
short-term growing conditions playing a large part.

Cocoa prices

The cobweb diagram can be used to explain the tendency for price
instability of agricultural products and commodity markets. Initially, we can assume a stable
equilibrium price, followed by a negative supply shock, such as a crop
disease, bad weather, political unrest or a war.

Cobweb diagram

Short run supply (Q1, at S1) ends up significantly less than planned
(Q). Price is now driven up to P1. Next year, planned output rises to Q2, but this drives price down to P2.

The process continues until the price is so low that
producers are driven out of the market. There is clearly a significant
information failure – farmers and growers are not fully aware of the
impact of their decisions in one year on the price of products in the
following year.

A cobweb effect can also be triggered by a positive
supply shock, such as an exceptionally good harvest.

Remedies

Buffer stocks

Buffer stocks are stocks of produce which have not yet been taken to market. They can help stabilise prices by taking surplus output and putting it
into a ‘store’, or, with a bad harvest, stock is released from storage.

A target price can be achieved through intervention buying and selling.

Ceilings and floors

The buffer stock managers are likely to establish a price ceiling,
above which intervention selling will occur, and a price floor, below
which intervention buying will take place.

Evaluation of buffer stocks

While buffer stocks can help stabilise price, there are
several
disadvantages, including:

Furthermore, some commodities cannot
easily be stored because they are perishable.

The system relies on starting with a good harvest,
indeed, without stocks in
the system it is not possible to react to a poor harvest.

Buffer stocks do not prevent the initial problem
from arising.

Critics argue that they distort the operation of
free markets and
prevent the price mechanism working effectively.

Finally, there is the potential problem of moral hazard,
which means that buffer stocks
provide an insurance against poor harvests and may encourage producers to
be inefficient.

Guaranteed prices

Guaranteeing a price to producers (at P1 in the
diagram below), irrespective of the output
they produce, is another way of stabilising prices and incomes.

A government or agency can
establish a target price, and then guarantee to pay farmers and growers
this price, whatever output is produced. If the market price rises above
this guarantee, the market price will prevail. But if the market price
falls below the guarantee, then the guaranteed price will prevail.

However, they can also be criticised because:

They encourage over-production creating a surplus of Q2 to Q1.This
problem is particularly associated with the EU’s
Common Agricultural
Policy (CAP).

They can promote inefficiency. For
example, farmers may question whether it is worth bothering to be
efficient if they are guaranteed a buyer.

There are also extra costs of storage or disposal.

Set-Aside programmes

Set-aside schemes involve farmers and growers being paid to take land
out of production, and are used widely in the EU and USA. Set-aside
can be effective because it can prevent surpluses happening in the first
place, and hence avoid storage, distribution and management costs.

Export subsidies

An export subsidy involves producers being paid a
subsidy to export their surpluses at artificially low prices. However,
other countries may retaliate, and protect their own producers from
cheap imports, because it can be argued that export subsidies are a form
of unfair competition.

Quotas

Over-production can be controlled by allocating
production quotas to producers. Quotas are agreed quantities that
individual producers must produce, and a quota system can help prevent
over or under production in response to economic shocks.

Better information about future shocks

Another way to stabilise markets is to encourage
producers to make better use of the internet and computer technology to
predict the weather. This enables farmers and growers to predict the onset of other potential shocks so
that they
can react quickly. In addition, specialist knowledge and skills
can also be acquired by studying agricultural
courses
at specialist colleges.

The Common Agricultural Policy

The EU protects its farmers and growers through its Common Agricultural
Policy (CAP). Through the CAP, European farmers receive annual subsidies
of around £30 billion each year.

The evolution of CAP

CAP was created by the Treaty of Rome (1957) to ensure food supplies for
Europe, and provide a fair income for European farmers. Price support
schemes, such as guaranteed prices, were first introduced in 1962, and
became the main means of supporting European farmers.

By
the mid 1980s, over-production created massive surpluses and this led to
major reforms, including the use of set-aside programmes.

By
the early 1990s, there was a movement away from guaranteed prices towards
direct subsidies to farmers, irrespective of the output they produced.

The Fischler Reforms, of 2003, continued the process of decoupling
subsidies and farm output, and introduced a ‘green’ element to CAP,
forcing farmers to meet environmental and animal welfare standards.

The UK receives a controversial rebate against payments into the EU to
compensate for that fact that it receives relatively little income from
CAP in comparison with France and Spain.

Source: The Times, June 2005

Farming subsidies in the EU are based on the size of farms, so countries
with the largest farms gain the most.

France takes the biggest slice of the subsidies, with Spain and Germany
a distant second and third. French farmers receive, on average,
approximately €17,000 per capita.

Because the UK derives such a low proportion of its national income and
employment from farming, it is given a rebate as compensation.